Myths That Prevent Business Owners From Starting a Retirement Plan

Posted on by

We will debunk the myths that prevent business owners from having a retirement plan

As small business owners ourselves, we understand juggling priorities, finite resources, and the desire to build wealth through business ownership.

However, the top reasons for not having a retirement plan are based on faulty reasoning, false assumptions, and personal bias.

Top Reasons Business Owners Don’t Have a Retirement Plan

75% of non-retired adults have some form of retirement savings account and 70% save a percentage of their household’s income for retirement every year.

However, 34% of business owners have no retirement savings plan. And of the 36% that report owning an Individual Retirement Account (IRA), only 33% contribute consistently.

Why do business owners participate and contribute to their retirement at lower rates than the general population?

The top 3 reasons according to a Manta survey of 1,960 business owners reported by CNBC:

  1. “don’t make enough profit to save for retirement” (37%)
  2. “used my previous retirement savings to invest into my business” (21%)
  3. “plan to sell my business to fund my retirement” (18%)

These Excuses Employ Faulty Reasoning

Let’s go through them, one by one.

“I Don’t Make Enough Profit to Save for Retirement”

As a business owner with a profitable business, one of your first priorities is to secure your retirement. No one else is going to do it for you.

This argument is a false dichotomy. It is not a choice to EITHER pay expenses today OR secure your future retirement. You should commit to BOTH pay expenses today AND secure your future.

No amount is too small to start – even $50 a month can be the right amount to start.

“I Used My Retirement Savings to Invest in My Business”

Using your retirement savings to start/invest in your business is generally not a trade-off that can be economically justified. The concept of buying now and paying later doesn’t work for retirement (you can borrow for a business, but you can’t borrow for your retirement).

Even if you did choose to raid your retirement funds for business purposes, that doesn’t preclude you from saving for retirement starting right now.

“I Plan to Sell My Business to Fund My Retirement”

Many business owners are counting on the sale of their business to fund their retirement, but they are unaware of the extensive planning and preparation required to complete a successful business transition. Here are some findings from the Exit Planning Institute’s State of Owner Readiness in North Texas:

  • Business owners are insufficiently prepared for transition:
    • While 60% of owners said that they had a good idea of what their business was worth,
      • Only 13% had a formal valuation of their business in the last two years
    • 36% hadn’t determined how much money they need to net from the transition of their company
    • 68% hadn’t undertaken any pre-exit projects in the last two years to prepare for a transition
    • While 74% require the company to remain profitable for their transition to be financially viable,
      • Only 35% are confident of the success of their management team under new ownership
  • Business owners exhibit overconfidence bias:
    • 50% percent of all exits do not occur on the owner’s terms or timeline (death, disability, divorce, distress, disagreement, or unplanned opportunity), but
      • Only 41% of owners have a written contingency plan
    • 59% indicated they had multiple partners invested in their businesses, but
      • Only 36% said their buy-sell agreement was written and updated in the last two years
    • Only 20-30% of all businesses that go on the market actually sell
      • Professionals cite the owner’s overestimation of value as the #1 cause of failed deals

Most business owners have 80-90% of their net worth invested in their business but remain unaware that overconfidence and lack of preparation will kill their chances of a successful transition (and retirement).

These Excuses are Based on False Assumptions

This Pew Charitable Trusts survey of 1,600 small businesses lists owners’ top reasons for not offering a retirement plan:

  1. The expense of setting up a plan
  2. The administrative burden of maintaining them.

Two Small Business Retirement Plans To Consider

Both of the following plans were created for small businesses and have the following features:

  • Can be established using a short one or two-page form
  • Low start-up and operating costs
  • Do not require annual reporting to the Department of Labor (DOL) or the Internal Revenue Service (IRS)
  • Can scale beyond sole proprietorship as your business grows

So, now that you’ve decided to consider a company retirement plan, what are the options for small businesses?

SEP-IRA (Simplified Employee Pension)

It is NOT a pension plan, but rather a defined contribution plan funded solely through employer contributions. Employers must contribute a uniform percentage of pay for each participant, but can change the amount each year and are not obligated to make a contribution.

SIMPLE-IRA (Savings Incentive Match Plans for Employees)

Similar to 401(k)s, this plan is funded through a combination of elective salary deferrals by employees and required employer contributions each year. Employers must either match employee contributions (up to 3%) or contribute a fixed percentage of each participant’s salary.

The process to setup each of the above plans is quite similar:

  1. Choose a financial institution to set up your plan
  2. Sign the agreement; set up the IRA(s)
  3. Inform your employees about the plan/enroll them
  4. Deposit contributions in a timely manner

The SEP-IRA and SIMPLE-IRA are small business retirement plans that feature low costs and low administration.

Retirement Finance Fundamental:

  • The biggest mistake in retirement planning is spending too much today and saving too little for tomorrow

Don’t Fall Into the Trap of Forgetting to Fund Your Future

  • As a business owner, it is your responsibility to pay today’s expenses AND fund your future
  • You can borrow for your business, but you CAN’T borrow for retirement (so start saving today)
  • Business owners tend to over-estimate both the value of their company and their control over the terms an timeline of transition
  • There are business retirement plan options that are easy to start and feature low costs & low administration

Sources:

Whether this is a problem you are currently facing or just something that has been weighing on your mind, feel free to contact me via phone or email so we can discuss your situation, goals, and solutions.

steve4

I built my first career in management consulting, and have spent the last 20+ years putting my passion and skills to use in community and economic development. For the past seven years, I have provided business advice to hundreds of start-ups and small businesses.

Leave a Reply

Your email address will not be published. Required fields are marked *